YPF: When Politics Become a Factor

by Daniel Putnam | April 17, 2012 11:41 am

YPF: When Politics Become a Factor

Argentina’s government is playing a game of turn-back-the-clock.

On Monday, President Cristina Fernández de Kirchner announced that she will ask Argentina’s congress to take a 51% stake in energy giant YPF (NYSE:YPF[1]), a move that would effectively nationalize the company. Approval is likely since Kirchner’s party is in firm control of the nation’s congress.

A federal tribunal will determine the appropriate compensation for Spanish company Repsol (PINK:REPPY[2]), which currently owns the shares that are targeted for nationalization.

The Back Story

This marks a reversal of the trend that dominated the emerging markets throughout the late 1990s and early 2000s. During that time, the wave of privatizations resulted in governments largely getting out of the business of running large national corporations, including YPF. Still, it should be noted that the majority of Latin American governments continue to run their national energy companies.

Click to Enlarge The potential nationalization has been weighing on YPF shares throughout 2012. The company had come under government pressure after Argentina became a net importer of oil despite YPF’s large reserves. President Kirchner stepped up pressure on YPF to increase its production, and provincial governments took away drilling concessions for some of the company’s properties.

While there was no shortage of analysts who insisted that nationalization was unlikely, the stock continued to slide. Now, it’s apparent that investors should have heeded the signals coming from the government: YPF fell more than 11% on Monday before its shares were halted, bringing its year-to-date return to -43.7%.

The other notable victim of the news was the Spanish oil company Repsol, which owns 57% of YPF and is the primary target of the nationalization. According to Financial Times, Repsol’s stake in YPF accounts for 25% of its profits. The stock slipped 4% on Monday and is down 26.5% year-to-date. In typical fashion, analysts hit Repsol with a wave of downgrades after the fact.

The Implications for YPF

Back in February, I warned that YPF should be avoided[3] despite its attractive valuation and dividend yield. That remains the case today. While on paper the stock looks like a winner by any number of measures — especially the would-be 15% yield — it would be wise to stay away. Volatility is likely to be high in the short term, as the news flow in the days and weeks ahead is sure to be highlighted by talk of European Union sanctions and the questions about the price the tribunal will set.

“The Argentinean president has committed an illegal and unjustifiable act following a campaign intended to push down the share price of YPF and allow expropriation at a low price. This is just a way of covering up the social and economic crisis facing Argentina.”

This type of rhetoric is a recipe for extreme short-term volatility in YPF shares as the battle evolves.

The picture also is muddy on a longer-term basis. Political expediency — rather than sound financial decision-making — is going to play a greater role in the management of the company, which means that its shares are likely to trade with a permanent discount. Kirshner made a telling comment about how this move was about “recovery of sovereignty and control,” but she made no mention of profitability. This means higher expenditures, the influence of the “dead hand” of government and — most important — an inevitable reduction or elimination of the dividend.

The bottom line: While there might be a short-term “buy the news” trade once the tribunal comes back with its decision, the long-term outlook for YPF has dimmed considerably.

Does This Mean Anything for Emerging Markets in General?

The YPF nationalization is unlikely to have a broader implication for the emerging markets as an asset class. The Spanish government — hardly a paragon of sound policy in its own right — stated that the nationalization of YPF makes Argentina an “international pariah,” and the move should indeed result in an evaporation of foreign direct investment. Also, it’s not the first time Argentina has thumbed its nose at the global investment community: The country has nationalized both an airline and private pension funds, and it is responsible for the largest sovereign debt default in history.

This event therefore should be regarded as an isolated incident for now, but watch for any further indication that resource nationalization is becoming a more pernicious global trend.

The Bottom Line

The most important lesson of all is that rumors of potential government interference always should be taken seriously, no matter how many analysts downplay the threat. This is true not just in the emerging markets, but here in the United States as well — recall the initial reactions to tobacco litigation and Obama’s health care reform bill.

Once politics become a factor, fundamental analysis goes out the window — and that means it’s time for investors to stay away.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.